Microsoft feels impact of its transition to the cloud; end of XP migration boost

As Microsoft continues its transition to more of a mobile first, cloud first vendor, its traditional Windows and Office licensing businesses are feeling the impact, as its Q2 FY 2015 numbers show.

The second quarter of Microsoft's fiscal 2015 was a tough one for Windows, Windows Phone and its packaged consumer Office businesses.


(The Microsoft-provided chart above indicates D&C, or devices and consumer, licensing performance for the second fiscal 2015 quarter. For more on how Microsoft splits its reporting categories, see this explainer.)

Microsoft reported operating earnings of $16.3 billion, or 71 cents a share, on revenue of $26.5 billion, including integration charges for the Nokia purchase and restructuring. Wall Street was expecting second quarter earnings of 71 cents a share on revenue of $26.33 billion. Strong Surface Pro 3 and enterprise product and service sales led the charge.

Windows Phone revenues were down 61 percent compared to the year ago quarter, althought that was primarily due to costs associated with the integration of Nokia's handset business, which closed in the fourth quarter of fiscal 2014. That said, Microsoft did sell 10.5 million Lumia handsets in the quarter, which is an all-time high for the company.

Windows OEM revenues were down 13 percent compared to the year-ago quarter, with the business PC/Pro mix "returning to pre-Windows XP end of support levels," coupled with the new, lower-priced licenses sold to academic customers, according to the company. Microsoft stopped providing free support for Windows XP in April 2014, which led a number of its customers to upgrade.

Office Consumer revenues also were down 25 percent, compared to the year-ago quarter, due to more consumers buying Office 365 Home and Personal subscriptions, instead of Office preloaded on new PCs, along with declines in Japan's PC market, officials said.

Microsoft Office 365 Home and Personal subscribers increased to over 9.2 million, up 30% sequentially over prior quarter, according to the latest report. As of last quarter, that total was 7 million.

None of these trends is too surprising, given Microsoft is a company that's attempting to transition from a packaged/bundled software vendor to more of a services/subscription vendor.

Also, due to market pressures, Microsoft has dropped substantially the prices it charges its PC and phone partners per copy for Windows and Windows Phone. For devices with screen sizes under nine inches, Windows and Windows Phone are now free. And on tablets, as part of a new Bing SKU, Microsoft makes anywhere from zero to $15 per copy -- a marked drop from the days when the company could charge substantially more per copy for Windows.

Chris Suh, Microsoft's General Manager of Investor Relations, said the lower Windows revenues were more about what's happening in the business category. The boost Microsoft received in its Windows Pro business due to the end of support for Windows XP is tapering off.

Suh said given that the sub-nine-inch Windows category was basically non-existent a year ago, there were no Windows revenues coming from that end of the market a year ago. Suh said Microsoft saw good unit growth in Windows machines -- especially given Q2 was its holiday quarter, but the average-street price is lower, so that affects the overall profitability.

Overall, Microsoft's entire Office business, was down by one percent, revenue-wise, but Suh attributed that to the fact "that business is transitioning to the cloud." Overall revenues for "commercial cloud" -- a k a, Azure, Office 365 and CRM Online combined -- were up 114 percent compared to last year's comparable quarter, officials said, without disclosing the actual dollar value.

Office commercial (business) revenues were down 13%, due to declines in commercial PCs in the post-XP refresh cycle; the transition to Office 365 and weakness in Japan and China, Microsoft officials said. Licensing revenues in the commercial segment overall was $10.7 billion, down two percent compared to the comparable quarter.

Also, for those wondering, Bing -- which Microsoft also does not break out separately in its financial reports -- is still not yet profitable, according to Suh. He said Microsoft still believes Bing will break even some time in fiscal 2016, which kicks off on July 1, 2015.